9/30/2009 @ 7:35PM

Value In Construction, Not Housing

The housing market has offered some signs of hope in recent months. Existing home sales have increased for four months in a row for the first time in five years, according to the National Association of Realtors, and the group’s pending home sales index has risen six straight months–the first time that has happened since NAR started keeping track in 2001.

Home prices have also shown signs of leveling out, with the Federal Housing Finance Authority announcing Tuesday that its single-family home price index rose–albeit slightly–for the third straight month. Warren Buffett even recently cited dramatic changes in housing activity and prices, particularly in the mid- and lower-range categories, as a key sign that the economy is on the mend. All of that has sent the stocks of many homebuilders surging, with big players K.B. Home and
D.R. Horton
up about 140% and about 90%, respectively, since the March 9 low.

So, does all of this mean it’s time for investors to dive back into homebuilders, a group that was pummeled as much as anyone during the bear market? No, according to the 12 Guru Strategy computer models I run on Validea.com.

My strategies–each of which is based on the published approach of a different Wall street great–are finding homebuilder stocks to have extremely flawed fundamentals, and do not currently give strong interest to any homebuilding firm. In fact, most fall woefully short of getting any kind of interest from any of my models.

That does not, however, mean that the construction industry should be avoided altogether. My models are actually finding a number of good values among construction services firms that work mostly in either the commercial or government arenas.

Here’s a look at the best of the bunch. These firms all have strong fundamentals, and, amazingly, all increased earnings per share in both 2007 and 2008.

Granite Construction Inc.
: Based in California, Granite is one of the nation’s largest heavy civil contractors and construction materials producers and is best known for its transportation infrastructure projects. It works in the public and private sectors, and its projects range from small site developments to multi-billion-dollar federal projects–the latter of which makes it a potential beneficiary of the stimulus package’s infrastructure bent.

Granite, which has a market cap of about $1.2 billion, gets approval from the strategy I base on the writings of mutual fund great Peter Lynch–a model that is up about 47% this year and which has produced annualized returns of more than 10% since its 2003 inception (vs. 1.1% for the S&P 500). My Lynch model considers the stock a “stalwart” because of Granite’s multi-billion-dollar annual sales ($2.3 billion) and moderate growth rate of 18.8%. (I use an average of the three-, four- and five-year EPS figures to determine a long-term growth rate.) Lynch liked to keep a few stalwarts in his portfolio at all times because they tend to offer protection during downturns or recessions.

To find strong, cheap stocks, Lynch famously used the P/E/Growth ratio, which divides a stock’s price/earnings ratio by its long-term growth rate (adjusting the “G” portion of the equation for yield in the case of stalwarts, which often pay nice dividends). My Lynch-based model considers P/E/Gs below 1.0 acceptable, and those below 0.5 the best case; Granite’s yield-adjusted P/E/G of 0.52 passes with flying colors.

Lynch also liked companies that were conservatively financed, and the model I base on his writings targets firms with debt/equity ratios below 80%. At 37.9%, Granite makes the grade.

Comfort Systems USA
, Inc.: Based in Houston, Comfort Systems USA is a national heating, ventilation and cooling firm that has 85 locations across the U.S. It performs engineering, design, installation, energy assessment and repair and maintenance services for companies or organizations in a variety of fields, ranging from private businesses to schools to hospitals to industrial plants. It has a market cap of about $450 million.

Comfort Systems gets high marks from the strategy I base on the writings of hedge fund guru Joel Greenblatt. Greenblatt used a remarkably simple, two-step strategy to produce back-tested returns that more than doubled the market over a 17-year span. My 10-stock Greenblatt-based portfolio has been on fire this year, gaining 64% in 2009, and since its late-2005 inception the portfolio is averaging annualized returns of 10.6% while the S&P 500 has lost 4.3% annually.

The two variables this approach uses are return on total capital, which measure the strength of a firm’s business, and earnings yield, which measures the cheapness (or lack thereof) of its shares. Comfort Systems has a return on total capital of 35.6%, which comes in 243rd among the 6,000-plus stocks in my database, and its earnings yield is 21.0%, which ranks 16th. Its combined ranking in those two categories makes it the 35th-best stock in the market right now, according to my Greenblatt-based model.

Fluor Corporation
: Based in Irving, Texas, Fluor offers design, engineering, construction, project management and maintenance services to clients in a variety of areas, ranging from oil and gas production to power to mining to manufacturing. It has a market cap of about $9.8 billion, and over the past year has taken in almost $23 billion in sales.

My Lynch-based model is high on Fluor. It considers the stock a “fast-grower,” Lynch’s favorite type of investment–because of its 36.3% long-term growth rate. Fluor’s 13.41 P/E ratio and that growth rate make for a very strong P/E/G of 0.37, which falls into the model’s best-case (below 0.5) category. That’s a sign that this fast-grower is a bargain right now.

EMCOR Group
, Inc.: Based in Connecticut, this construction and facilities services firm does electrical, mechanical, lighting, air conditioning, heating, security, fire protection and power generation systems work for companies in a wide variety of industries. The $1.7 billion market cap company gets high marks from both my Lynch- and Greenblatt-based models.

My Lynch-based model considers EMCOR a “fast-grower” because of its 48.8% long-term growth rate. That growth rate and the stock’s 8.94 P/E make for an excellent P/E/G ratio of 0.18, easily falling into this model’s best-case (below 0.5) category. While you shouldn’t expect the firm to grow at such a fast pace indefinitely, EMCOR is selling at a low enough P/E that it would still be a good value at even half that growth rate.

In addition, EMCOR appears to be conservatively financed. Its debt/equity ratio is just 17.4%, another reason my Lynch-based model is so high on the stock.

My Greenblatt-based model, meanwhile, likes EMCOR’s 21.8% earnings yield (which ranks 14th out of the thousands of stocks I screen) and its 45.6% return on total capital (which ranks 139th). The combination of those two scores make EME the 12th-highest-rated stock in the market right now, according to my Greenblatt model.